Action on Yen Shows G-7 Still an Effective Firefighter

Central bank intervention versus the yen on Friday showed that while the Group of Seven nations has lost prominence as a forum to discuss the global economy, it remains the only effective firefighter in world markets.

During the financial crisis of 2008-2009, talks on correcting imbalances and coordinating policies in the global economy shifted from the G-7 to the Group of Twenty, a larger body which includes emerging powerhouses such as China.

The G-7, which comprises Britain, Canada, France, Germany, Italy, Japan and the United States, was eclipsed. There was talk among analysts and officials of cutting back its meetings, even of winding up much of the group's activities. But when France — which chairs both the G-7 and G-20 this year — sought to calm volatile global markets this week in the wake of Japan's tsunami, it turned to the more agile G-7.

The willingness of the G-7 to get involved, and the success of Friday's intervention, may be good news for financial markets in general, by showing a global body still exists that can act quickly and aggressively against wild market movements.

"We will always need something like the G-7 because we need to be able to make swift decisions," said Gilles Moec, senior economist at Deutsche Bank.

"The G-20 does not have much financial firepower beyond the countries which are members of the G-7, and sometimes you need to make extremely swift decisions in a very unconstrained manner. In this kind of setting, the G-7 regains all its strength."

MARKET POLICEMAN

The G-7's role as the policeman of global currency markets was born in the 1980s when major members of the group reached the Plaza Accord of 1985, an agreement to coordinate foreign exchange intervention to drive down the dollar.

This week's intervention against yen strength, which was threatening to destabilize Japan's economy in the wake of the tsunami, was the G-7's first intervention since it came to the aid of the newly launched euro in 2000.

The result suggested the G-7 retained its technical skill and the respect of the markets; the intervention drove the dollar up two full yen to as much as 81.83 yen. The Bank of Japan intervened heavily; during European trading hours, European central banks appeared to spend less money, but the dollar still retained most of its gains.

The intervention also delivered a broader psychological boost to markets including equities, suggesting investors were pleased that global authorities were acting to preserve stability.

"The intervention has been extremely important, not just for the yen," said Ian Stannard, senior currency strategist at BNP Paribas. "Globally, it has sparked a rebound in asset markets as risk appetite is being restored to some extent."

G-20 DIFFERENCES

The G-20, created in 1999 in the wake of the emerging market crises in Asia and Latin America, was able to form a united front at the height of the global crisis in 2009, agreeing to bolster the firepower of the International Monetary Fund.

But as the crisis has receded, divergences between rich and emerging countries have reasserted themselves, with members struggling to reach agreement at a conference in Paris last month on how to measure imbalances in the global economy.

A conference call of G-20 deputy ministers on Thursday discussed the crisis in Japan, but it was limited to an initial exchange of views and a show of solidarity, a G-20 source said.

The source said the call did not even broach the issue of currency exchange rates — which is a sensitive subject within the G-20 because Washington and other governments are pressing Beijing to let the yuan float more freely against the dollar.

"As long as in emerging markets, financial markets do not act by strict market principles, it's still the G-7 countries which are going to send the right signals," said Moec.

NOT ENOUGH

Despite the G-7's success on Friday, its ability to stabilize the global economy and markets will remain limited.

Sustained weakening of the yen will become easier when the U.S. Federal Reserve eventually unwinds its ultra-loose monetary policy, known as quantitative easing, Barclays Capital noted in a research report. But there is no sign that the G-7 is engaging in serious talks about coordinating monetary policies.

Nor is the G-7 expected to address pressing problems such as volatile global commodity prices, something France has put at the top of the G-20 agenda.

"There will be no G-7 action ... to address present massive malfunctioning of global commodity markets, with speculative fever there driven in considerable part by bi-polar monetary disorder in Washington and Beijing," said Brendan Brown of Mitsubishi UFJ Securities.

Many analysts see China's reluctance to appreciate the yuan sharply as a major source of global instability, but the G-7 cannot engineer a change in yuan policy because China is not a member, and the G-20 has been unable to address the issue squarely because of China's opposition.

Central bank intervention versus the yen on Friday showed that while the Group of Seven nations has lost prominence as a forum to discuss the global economy, it remains the only effective firefighter in world markets.
During the financial crisis of 2008-2009, talks on...